Britain’s personal debt is increasing by £1million every 4 minutes. As the debt rises lenders are experiencing more defaulting customers and subsequently suffer from falling profitability, rising costs of bad debt and bad customer experiences when collections are requested. It’s a downward spiral.

Lenders are coming under increased pressure to assist their customers. The Banking Code revisions, that came into effect in March 2008, state that:

• Lenders should use their systems for pro-active spotting of customers who may be getting into financial difficulties.
• Institutions should then contact such customers to emphasise that, if they are in difficulties, a ‘sympathetic and positive’ approach will be taken and to provide details of independent, free, money advice agencies.

How can the retail banking industry work out which customers are likely to get into debt before they start to default and identify and keep those customers who, in the long-term, are likely to spend more money with them? A strategy is needed to deal with this and Pre-delinquency Management is the upcoming methodology.

Identifying the risk

Anyone can spot a customer who stops making payments. The trick is to spot the ones who are about to stop making their payments. It would be great to have a crystal ball to identify those customers that were simply going through a tough time with their finances but long-term would remain high value customers and those that would fall delinquent and become a bad-debt statistic.

Pre-delinquency Management is discussed here as a strategy, methodology and technology that emulates that crystal ball.

Predicting Delinquency:

Organisations are now able to put a strategy in place to identify customers likely to fall into bad debt before they do so. There are many indicators, which, when analysed together through sophisticated modeling, can help predict payment defaults.

Modeling algorithms are set to work on customer data to identify changes in customer behaviour. The resulting score card identifies the propensity to default. Models should be able to evolve, adapting over time to identify the most/least responsive customers.

Drive up lifetime customer values

Once customers most likely to default are identified the next step is how best to handle them. The secret is recognising how to profitably manage different types of customer through this phase, whilst ensuring fair treatment. One size does not fit all. Strategies need to be specific, appropriate and dynamic. Managed properly, treatments have the ability to not only retain profitable customers but drive up lifetime values. This is the result of a positive customer experience generated through supportive PDM interactions.

Treating Delinquency

80% of the British population admit to regularly overspending and getting into debt, which is the biggest cause of stress (over and above job or family) and 75% find money the hardest subject to talk about with their partners. Thus treatment strategies need to be handled with skill and experience in order to generate the best customer reaction possible. These could include the automatic generation of a letter, or a telephone call, to offer help such as changing credit limits or suggesting a new payment schedule.

Whatever best next action is appropriate the treatment should be managed centrally, with intelligent prompts to call centre advisors to guide them through these actions. Interactions across multiple channels may also be appropriate depending upon the level of predelinquent risk.

Drive down impairment costs

A lender’s dream: A significant reduction in the provision for bad debt and less stringent lending policies. The dream can become a reality if pre-delinquency management strategies and tools are in place. If delinquency is prevented or at least reduced, using a pre-delinquency solution, then there are tangible benefits for organisations and their customers:

• Provision for impairment can be reduced
• The number of accounts moving into collections will be reduced
• Revenues can be maintained by keeping profitable accounts alive
• The lifetime value of customers can be increased
• Delighted customers will tell their friends and remain loyal
• Customers that are likely to remain bad debtors can be identified and acted upon before the debt has amassed

A pre-delinquency strategy addresses the problems of lending, such as increasing credit card limits and targeting inappropriate offers to customers who are struggling financially, and banks are able to demonstrate corporate social responsibility

This paper explores how to analyse customer behaviour in order to identify potential bad debtors. How to identify customers at different levels of risk and maintain lifetime values, whilst reducing the overall bad debt. How to create a technology infrastructure to help predict, treat and prevent delinquency early.

Dealing with a 1.4 trillion pound problem

Consumer debt in the UK is growing at the rate of £1 million every five minutes. The average household owed more than £9.052 in unsecured debt in January 2008. Anecdotal evidence leads us to believe the debt burden has risen still higher since then. Britain has become the most indebted nation in Europe with more than £1.4 trillion in personal debt. Many lenders have been caught out by customers defaulting on these debts leading to lower profits as they write-off the debts of customers who simply cannot pay.

This worsening bad debt situation is caused among other factors by the easy availability of credit, together with rising interest rates and mortgage repayments. Like banks, credit card companies are beginning to see increasing proof of a declining ability to pay among their customers. Profits are falling as overall charges relating to the writing-off of debts increase.

Bad debt means tougher lending – and lost opportunities

This spiral of bad debts has had a dramatic impact on banking practices. Not only have financial institutions increased their provisions for bad and doubtful debts, most have adopted a much more stringent lending policy:

• Building societies now turn down more unsecured loan applications, up to as many as 60%
• Credit card companies are refusing more credit card applications, as many as 55%
• Lenders are cutting credit limits
• Restrictions have been imposed on the level of cash advances on credit cards
• Building societies are turning away mortgage applications – in some cases more than 50%
• Lending portfolios have been dramatically reduced

Tougher lending policies are not in themselves the answer. As banks admit, the traditional methods and software tools they use to deal with bad debts are clumsy, wasteful and one-dimensional. They simply force the organisation to react to delinquency after it has already occurred.

This causes:

• Lower profits – as lenders fail to predict which customers are the most likely to default before its too late.
• Higher costs – involved in recuperating bad debts.
• Lost opportunities – missing the chance to drive up customer lifetime values.

The focus on reducing the amount of new business and lowering credit, may positively impact the impairment provision but also creates lost opportunities regarding potential revenue.

The traditional bad debt lifecycle

Lenders traditionally take a reactive approach to dealing with bad debt. Even in circumstances where a potential delinquent has been identified, more often than not there is little time to take action and the account still slides into default.

In periods of strong economic growth and low interest rates, as in the last few years, the qualifying line is drawn low, and more customers are recruited than would be acceptable in tougher times. As financial circumstances worsen, many potential delinquents are already in the system, put there by the more relaxed rules of the previous period. As the graph shows, using the typical collections approach to bad debt management means the costs of delinquency rise through the lifecycle.

Introducing Pre-delinquency Management

The bad debt problem is forcing financial institutions to look for solutions that can accurately predict which customers are likely to default on their payments so they can implement the right treatment strategies to reduce the risk, while demonstrating responsible care for those customers.

Current collections activities are primarily triggered at account default, which hinders the ability to undertake proactive and preventative action. Organisations today are looking to develop better strategies that drive down impairment costs by identifying customers likely to fall into delinquency, then triggering the right treatment strategies.

As a result many accounts will avoid moving into collections, returning safely to the sales and service phase and increasing customer retention periods. Alternatively, early identification and activity provides the option of managing out people who are always going to be bad debtors. Both approaches reduce costs and increase profits.

The discipline of pre-delinquency management:

• Significantly reduces the provision for impairment
• Drives down the cost of collections
• Operates alongside existing banking systems, including CRM applications
• Identifies customers likely to fall into bad debt before they do so
• Provides treatment strategies to help those customers and turn as many of them into long term profitable customers as possible
• Focuses efforts on the most profitable customers

The focus of traditional pre-collections or early arrears activity has not allowed lenders sufficient time to have a significant impact on customer behaviour. A successful PDM programme focuses on early identification of stressed behaviour; the period 6 to 9 months prior to delinquency. This provides adequate time to get accounts back on track, as shown in the diagram.

For example, a bank may launch a new low interest credit card that is highly differentiated from the competition. It receives 500,000 applications for the new account and accepts 80 per cent of these. In the traditional debt management lifecycle, there would be little understanding of how many of these 400,000 customers would turn into liabilities until they had already run up debts that could not be serviced. As a result, unavoidable cost would be expended in collections, recoveries, litigation and write offs.

A PDM programme would identify early signs of potential problems. This allows intervention and remedial action, resulting in a lower number of defaults, collections and possible write-offs.

The PDM dividend

Implementing a PDM programme allows an organisation to control downstream debt before it becomes a problem. We call this the ‘PDM Dividend’ and it has four main effects:

• Reduces the level of bad debt overall because customers are helped to avoid defaulting
• Identifies customers who are likely to remain bad debtors and allows an organisation to manage the closure of their account
• Increases the lifetime value of existing customers who have been helped to avoid becoming delinquent and who go on to be more financially secure in the future
• Provides confidence, allowing financial institutions to ‘lower the bar‘ when acquiring new customers, as the PDM strategy delivers results

Fundamentals of good PDM

Identify potential pre-delinquents – early

The earlier that possible delinquents are identified, the better the chance an organisation has of positively affecting the customer’s behaviour. Through analysis of existing behavioural and transactional customer data, strong predictive analytical models can be created to indicate the most likely future outcome. The key here is the early identification of potential delinquents

Having developed the predictive models, speed of analysis is of the essence. As soon as possible after the customer data has been refreshed, the predictive models should be applied to the customer base as a whole. This will result in a list of customers most likely to default. The sooner the list can be created and utilised to facilitate initial customer contact, the less chance there will be for error.

Over time, the models used to predict delinquency will need to evolve. As customer behaviour changes, in line with both personal and external financial pressures, the customer attributes and values that influence the predictability of the models will also change. The flexibility and speed of such change will have an impact on the overall long term success of any PDM programme.

Understand customer circumstances

Pre-delinquency by its very nature suggests that a customer has been identified as a potential risk before default occurs. Therefore, it is necessary to proceed with a degree of sensitivity. This is an essential step in any effective PDM programme, as many customers may not recognise that they are beginning to struggle financially. It is beneficial to contact the customer first to determine the full extent of their circumstances. This in turn may affect the appropriate remedial activities.

There are many benefits that arise from handling this initial call correctly. Tactful discovery of potential problems followed by appropriate help and advice has a positive impact on customer satisfaction. Delivered consistently, this will help to increase customer lifetime value and build a caring brand.

Select and implement treatments

During the initial call to the customer the advisor should have the ability to select and implement a remedial action, recorded as part of a full audit trail. The action would depend on the level of risk and sensitivity and may include:

• A call or letter to offer help and advice
• Offering to move unstructured debt to structured debt
• Establishing a new payment schedule
• Changing credit limits
• Targeting with appropriate new offers

It should be recognised that during the call, advisors will require flexibility in selecting what they consider to be the most appropriate action. They are in the best position to diagnose the customer’s previously identified behaviour and revealed circumstances.

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Review effectiveness

The importance of reviewing the effectiveness of any treatment taken should not be underestimated. It is important that an organisation has a view of the actions taken, any changes in behaviour following PDM intervention and the accuracy of the initial analysis.

Ultimately, the greatest indicator of success would be the ability to compare the change in behaviour of treated predelinquents against a non-treated control group of identified pre-delinquents. This is an ever evolving process and evaluation of the effectiveness of predictions made will assist in developing the most successful treatments and activities in the future.

From ‘tactical’ to ‘strategic’ PDM

Every day that goes by without the ability to identify, interact meaningfully and treat pre-delinquent customers, increases the number of accounts moving into collections. The servicing costs of the collections process may be expensive but are less significant than the write-off of outstanding balances that may follow.

A quick remedy would be to implement a paper-based PDM initiative. This would allow the organisation to understand how best to interact with customers likely to default and learn which remedial actions have the most impact.

An alternative to this approach would be to implement a tactical software solution to support the role of the pre-delinquent advisor. This would allow advisors to interact with a larger number of identified customers, more quickly. Such a solution should:

• Identify those customers displaying stressed behaviour
• Generate and distribute initial interactions across the team
• Display necessary customer information and the reason for the interaction
• Support the capture of information
• Provide flexible options allowing the selection of remedial actions
• Deliver a consolidated view onto predelinquent activities across customers, providing a real-time insight into the success of the initiative

Incorporating PDM into the existing sales and service operation

Over time, the organisation will learn not only how to run a PDM operation but how to run it well. It will see benefit in incorporating some or all elements of the tactical solution, into the broader business operation. For example, the ability to interact with customers over multiplechannels may already exist but lack the mechanism to manage appropriate predelinquency activities or messaging.

Where the initial PDM solution was only designed to deliver a short-term, tactical fix, the transition to support operations outside of the collections function may prove difficult and expensive. In such a scenario, the options would be to either procure a new, more capable solution or develop PDM support into existing systems. Both have high cost, effort and time implications. Neither offer re-use of the initial PDM solution investment.

One approach is to seek a solution that delivers the initial requirements, knowing that future capability can be delivered through integration with existing applications. This avoids large modifications to current systems and ensures further return on the initial investment.

A new framework for debt management – how Portrait’s PDM solution delivers

Portrait’s PDM solution is designed to support initial, tactical initiatives and serve existing sales and service systems with PDM capability. This is achieved through the delivery of the following:

• The supply of a desktop user interface, specifically designed to support the role of the PDM advisor
• The ability to expose underlying analytics, business process and real-time decisioning (as utilised through the user interface described above), to existing applications

Such a design supports the delivery of a flexible, multi-channel PDM solution that can either operate as a stand-alone pilot application or enhance existing sales and service platforms. This allows the following ideals to become reality:

• Utilise PDM propensity models to suppress pre-delinquent suspects from existing sales and marketing campaigns
• Interact with pre-delinquent customers over multiple-channels, as appropriate to the risk identified
• Automate the interaction with predelinquent customers across channels
• Present a selection of remedial activities into existing sales and service platforms
• Dynamic activity recommendation, completed in real-time as information changes during the interaction
• Prompt sales and services advisors of appropriate PDM activity in real-time, upon receipt of a general inbound call
• Display appropriate PDM messages upon customer access to existing web channel

Predict – Identify customer attributes that suggest early signs of pre-delinquent behaviour and apply such criteria to the customer base as a whole.

Discover – Customers should be treated as individuals and different levels of predelinquent behaviour will exist. It may be necessary to collect missing information around the customer to better understand their identified behaviour.

Manage – It may not be appropriate to treat all identified pre-delinquent customers in the same manner. The treatment applied will be influenced by the customer profile, type of product and the perceived level of pre-delinquency

Monitor – Economic pressure and therefore customer behaviour will change. The evaluation of the identification and treatment elements of a pre-delinquency strategy require continual evaluation to ensure the most effective results.

These elements enable an active approach to managing potential delinquents earlier in the lifecycle, with the aim of intervening before the first missed payment. This provides a solution that allows lenders to predict potential delinquency, help customers manage their debt and reduce write-offs as a result.

The Benefits of Portrait PDM

Collections efforts are too expensive and too late. By predicting and managing delinquency before it occurs, Portrait PDM delivers the following benefits:

• Enables treat customers fairly principles
• Reduce the number of accounts moving into collections
• Maintain revenue by keeping accounts live
• Identify new revenue opportunities
• Demonstrate sensitivity and offer advice when needed most
• Drive up customer lifetime values